The Impact of Subsidies on the
Affordability of Modern Energy Services by the Urban Poor in Ethiopia: The Case
of Electricity and Kerosene

By

B. Kebede, E. Kedir, A. Abera and S. Tesfaye

EXECUTIVE
SUMMARY

Estimates
of the total energy consumed by households in terms of kerosene and electricity
equivalents are calculated. This is done by converting all fuel used by
households into energy units and computing the corresponding kerosene and
electricity that can provide the same level of energy. Energy use significantly
varies across income groups and between different urban areas. For example, the
mean energy consumption of non-poor households is 2.3 times that of poor
households. As expected, total energy consumption consistently increases with
per capita expenditure deciles, with the richest decile expending 2.8 times that
of the poorest one.

The value
of kerosene and electricity equivalents (including equipment used) gives energy
cost estimates for households. The energy expenditure is used as a proxy for
purchasing power of households. The comparison of the cost estimates with the
mean energy expenditures indicates the affordability of the fuel. This
comparison indicates that even without subsidy, the cost of kerosene is
marginally lower than energy expenditure. This result indicates that the removal
of kerosene subsidy would not significantly impact the affordability even for
poor households. Similarly, kerosene subsidies do not seem to be important in
improving the affordability of kerosene to the average household in different
urban areas. Results for per capita expenditure deciles indicate that the effect
of kerosene subsidy even on the poorest of the poor is minimal.

A similar
comparison for electricity indicates that electricity is too expensive for the
average household and more so for poor households. Therefore, subsidies are not
important in making electricity affordable to the urban poor. Since fixed costs
are important in the use of electricity, the comparison of costs and purchasing
power (with and without subsidies) is also done by amortising the cost of
electric equipment over their lifespan and converting them into present values
by using an interest rate. The results (without the consideration of
depreciation) indicate that poor households do not have the purchasing power to
cover the upfront costs of electricity services. However, if the costs are
spread over the lifespan of equipment, even poor households can afford to pay
for electricity without subsidy. The most important obstacle for poor households
to access electricity seems to be the upfront costs.

The results
indicate that subsidies on both kerosene as well as electricity do not play an
important role in facilitating access to modern energy services by the poor.
The results also indicate that the majority of the urban population can afford
unsubsidised kerosene and electricity if arrangements for the amortization of
fixed costs, particularly for electricity, are provided. The above results have
far-reaching policy implications. First, the subsidies on tariff do not seem to
play an important role in affecting affordability of electricity to poor
households; the overall changes in the cost to energy expenditure ratios are not
significant. Second, given a mechanism that can spread costs over relatively
long periods of time, poor households can afford electricity even when supplied
without subsidy.

Fixed costs can be spread over longer periods of
time at least in two ways. The first is through long-term contracts with
electricity and equipment suppliers that enable households to pay the costs
(including interest payments) over longer periods of time. This will spread
expenses to households as well as enable suppliers to recover costs. The second
mechanism that can be used to spread costs is credit. If credit facilities are
available to poor households, they can cover the upfront costs and pay their
debt over longer periods of time. Results indicate that given a longer repayment
period, poor households can cover the cost of electricity services. In other
terms, if a mechanism that enables households to bring their future income to
the present is created, they can afford unsubsidised electricity.

Further
analysis is undertaken to determine the distribution of kerosene and electricity
subsidies among urban households in Ethiopia. Results indicate that the
non-poor capture most of the kerosene and electricity subsidy. In addition, mean
subsidy per household and total kerosene and electricity subsidies consistently
increase with per capita expenditure deciles – higher income groups capture a
higher level of subsidies. When the data is controlled for household size and
location, the amount of kerosene and electricity subsidies is significantly and
positively correlated to household expenditure. An increase in household
expenditure by one Birr increases kerosene and electricity subsidies by 0.10 and
0.16 Ethiopian cents, which are significant coefficients. These results
reiterate the findings that non-poor households capture most of the subsidies.

The study
also examines the role of kerosene and electricity subsidies in public sector
finance. The overall electricity sector subsidy is very small implying that the
burden on public finance is also minimal. However, this is as a result of
cross-subsidisation, with customers in the inter-connected system subsidising
those in the self-contained system. In addition, commercial and industrial
customers pay higher tariffs than the long run marginal costs while domestic
customer with relatively smaller consumption pay less than long run marginal
costs.

This paper is available on an exchange basis. If you find
it to be useful,
we encourage you to send us any relevant publications from your
organization. To request for the full paper, please fill in the
publications request form